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Ignore This Misleading Video Game Report

It's high time that investors accepted the fact that the leading industry report is no longer meaningful.

On March 14, the research firm NPD released its February sales figures to the usual groans. Sales were down again -- again! -- and one NPD analyst pointed out that with the same number of February releases in the top 10 as a year prior, sales of those games were down 30%. But the figures have come under scrutiny over the last year, as NPD captures only physical sales figures, not digital sales. The digital sales numbers that the company releases are estimates, determined through consumer research and work with some companies.

The group contends that the figures are still meaningful, as most of the retail action comes from physical sales of AAA titles. Unfortunately for investors, is that it's no longer clear if that's the case. Because NPD is estimating digital sales, it doesn't know how big that section has grown. Two of the largest distributors of digital gaming content, Apple and Valve, don't even release sales data granular enough to determine how big the segment has grown.

Source: Stock.XCHNG.

The challenge for investors will be weaning themselves off of the need for monthly data, which is growing less and less relevant, and developing a new way of thinking about the industry.

Digital distributionOne of the confounding points in all this -- and one of the biggest reasons to ignore NPD -- is that Valve software keeps its books tightly shut. Valve is the company behind Steam, a video game store that's grown popular over the past few years. Last year, Forbes estimated that the owner of the company, Gabe Newell, had a net worth of $1.5 billion. That estimate was based in part on the value that Valve is likely generating from its over 40 million users.

The revenue those gamers generate is growing quickly, too, up between 30% and 50% annually, according to Valve's economist in residence. That aligns with Newell's claim this year that 2012 "business" -- which could mean units sold, revenue taken in, or something else -- was up 50%. Those sales are slowly going to make up a larger portion of the revenue generated by Electronic Arts(NASDAQ:EA) and Activision Blizzard.

The president of EA Labels, Frank Gibeau, caused a minor fracas last year when he claimed that NPD was "totally irrelevant," saying, "We don't even really look at it internally anymore." It's easy to see that as one executive ignoring bad news, but it makes more sense given a comment that Newell made. He said that last year, when Valve's multiplayer Dota 2 updated, the traffic it generated accounted for "two percent of all the mobile and land-based internet activity." It's clear digital distribution is a significant shift.

The realityThe unfortunate reality is that video game sales are going to be harder to forecast and track. A good parallel is the monthly retail report released by the Commerce Department. It gives a decent overview of a very, very big industry, but for individual stocks, it's almost meaningless. Instead, investors view it as a bar to be surpassed. Eventually, that's how the NPD report -- if it goes unchanged -- will be viewed.

It could do better by building the sorts of connections required to make an honest assessment of total digital sales. The estimate that it makes now seems both dubious and worthless. I can't imagine reading an NPD report on digital sales and making any meaningful investment decision. But that could change in the future, with new relationships and technology.

The bottom lineFor now, investors need to accept that digital sales are going to be a growing trend, and a growing information gap. That may mean being less active in trading in the video game space, and waiting for bigger, company-specific news items. For instance, EA's CEO just stepped down -- that's probably going to affect your investment thesis. But hanging on for outdated information from NPD isn't going to cut it anymore. Both EA and Activision are up over the past 12 months, even as sales have been in a tailspin, if NPD is to be believed. If that's indicative of the data quality in the reports, then count me out.